In times of new global economic realities, the stabilizing potential of Sovereign Wealth Funds (SWFs) for financial global markets is widely recognized. At the same time concerns about their opaque nature and their motives have arisen.
The paradigm shift of SWF’s investment policies toward equities and alternative investments and their geographical diversification has initiated considerable controversy over possible implications for the OECD and the European Common Market and has triggered efforts toward a regulatory response.
These regulatory initiatives have been fuelled by the startling growth of SWF assets, and probably even more by a number of major investment decisions made by individual sovereign funds and other state-owned or state-controlled corporative entities. Their profile has been raised through a series of recent significant acquisitions in Europe and worldwide.
In line with international efforts, the European Union (EU) by the end of 2007 acknowledged that an internationally agreed code of conduct on SWFs — under the auspices of the IMF — is the most effective and proportionate way to address concerns that the cross-border operations of some SWFs could interfere with the normal functioning of market economies.
The EU decided not to take legislative action, but to support IMF and OECD standards, based on close coordination with the US in the Joint Investment Dialogue. Addressing SWFs, José Manuel Barosso, president of the European Commission, outlined that a “common approach at EU level is essential, in order to avoid distorting the single market with incompatible national responses” and emphasized the need for “cooperative efforts” between recipient countries and SWFs. Yet, he asserted, “that European legislation might be applied in the future, if transparency through voluntary means could not be achieved.” Faced with the challenge of maintaining its constitutional commitment to an open investment market on the one hand and taking decisive action to prevent future crises and shore up 27 national economies and the Common Market as a whole on the other hand, the EU and its member states have come under pressure to reconcile national and European regulative standards and to adjust these policies within an internationally elaborated regulatory frame.
Constitutional Flexibility
In fact, the European Commission abstained from legislative action and favored a voluntary code of conduct intended to avoid uncoordinated responses among its member states. EU’s legal framework concerning a common commercial policy, including trade and investment, has in several previous debates been challenged by the member states.
According to EU’s legal framework, investment flows follow the principles of free movement of capital. Yet, the commitment to free movement of capital is not absolute as it is regulated and limited on EU as well as on member states levels. The European Parliament and the European Council may thus adopt measures by qualified majority on the movement of capital from third countries. If these measures imply a step backwards of Union Law concerning the liberalization of the movement of capital, unanimity would be required.
Nevertheless, Foreign Direct Investment (FDI) does not currently squarely fall under EU’s Common Commercial Policy, as “investment” in general was not part of the respective articles of the EU Treaties. In the Treaty of Lisbon — which followed the Treaty of Maastricht, Amsterdam and Nice — we find a controversially drafted article which mentions foreign direct investments in the wording of the Common Commercial Policy, next to trade in goods and services and the commercial aspects of intellectual property. Yet, Lisbon’s “Reform Treaty” misses to clarify the allocation of competencies which in fact might intensify and revive the debate.
The dispute between the Commission and the member states in respect of the legal authority concerning the conclusion of International Investment Agreements (IIAs), which resulted from the above mentioned constitution, has in the past been referred to the European Court of Justice (ECJ). The latter in previous lawsuits argued that the responsibility over investment agreements with third countries falls under member states’ competence.
As hitherto, the EU member states will continue using their rights according to the “Merger Regulation” to develop and use national instruments to take appropriate measures to protect their legitimate interests — other than competition — as long as these are nondiscriminatory, proportionate and compatible with other provisions of international regulations and Community Law. Officials from the GCC assume that these national mechanisms might be used to control and condition SWF investments or any other investors henceforth.
Several EU member states, including the United Kingdom, France and Germany, have legislation on the national level in place that allows them to deal with SWFs:
France regulates foreign investment in a separate code of law, setting up reporting and review mechanisms which ensure that the authorities are aware of individual foreign investment activities. Accordingly, information necessary for an assessment can be gathered and transactions within well-defined time frames reviewed.
The French model is adopted to some extent by Germany’s Federal Ministry of Economics and Technology as it came up with a bill in early November 2007 for the amendment of the Foreign Trade Act of the year 1961. The revision is set to establish a reasonable review process, which might be implemented in 2008. By screening on a case by case basis, German authorities will be able to block certain acquisitions of foreign investors in German companies (in which they would gain 25 percent or more of voting power), if such cases have been classified as a threat to the public order or national security — as defined by regulations of the EU and the rulings of the European Court of Justice — within three months after the acquisition. It is noteworthy, that Germany — unlike several other European countries — does not name particular industries as sensitive to national security considerations, but reserves its right to decide on a case by case basis whether an enterprise is of “strategic relevance.”
The United Kingdom is following a less formal, however discrete approach, in evaluating and prohibiting foreign investments that are considered against national interest.
Coordinating Initiatives
A unified European approach was essential in order to avoid a fragmentation of investment regulations as well as an uncoordinated series of national responses, especially because several EU member states — as stated above — had initiated a review of national investment laws. In the communication, the Commission clearly laid down its position proposing a “balanced and proportionate unified approach” of its member states. In line with this concept, the Commission on the one hand seeks to protect legitimate national policy interests through enhanced transparency, predictability and accountability criteria for SWF investments without, on the other hand, falling into the trap of protectionism — pursuant to its commitment to maintain an open investment environment. Overall, the Commission’s move represents the bloc’s first attempt at addressing SWFs activities at EU level, aiming to balance concerns over the alleged lack of transparency while contributing to international efforts to set up a framework for improving the openness and accountability of the funds.
The EU declared that it would follow the approach of IMF and OECD suggesting a voluntary code of conduct for SWFs with a focus on good governance and transparency.
Accordingly, a variety of areas, including rules on allocating and separating responsibilities within the governance structure, could be covered. The code of conduct could also call for public disclosure of an investment policy that defines the overall objectives and could require operational autonomy for the SWF to achieve its defined objectives. Besides, it could ask for the disclosure of the general principles governing a SWF’s relationship with governmental authorities and the publication of general principles of internal governance that provide assurances of integrity.
The proposal also suggests that the code should include the development and issuance of risk-management policies. Provisions related to transparency might include annual disclosure of investment positions and asset allocation — particularly for investments for which there is majority ownership — as well as clarification on how the ownership rights are exercised. In addition, it could include disclosure of the use of leverage and the currency composition, as well as size and source of an entity’s resources. Information on the home country regulation and oversight governing the SWFs may also be asked for.
Coherent Strategies
By the end of March 2008, the US Treasury Department laid out a series of principles governing investment activities for both funds and recipient countries. The accord was signed between the US Treasury Department, Abu Dhabi Investment Authority (ADIA) and Singapore’s Government Investment Corporation (GIC) and backed by the world’s third largest SWF, the Norwegian Government Pension Fund. Most likely, this development will increase the pressure on smaller SWFs in the Gulf to follow. Recent conciliatory moves by international and European representatives have stressed the need for a “cooperative dialogue”, reacting to the resentments, which the world’s largest and Gulf’s biggest SWFs have articulated. Yet, Gulf officials expressed their concern that individual EU member states might translate a voluntary code of conduct into compulsory national jurisdiction.
The geo-economic relationship between the EU and the Gulf cannot be overlooked or understated. In 2007, the GCC member states have been able to build their net foreign asset position to $1.8 trillion, as the latest research of the Institute of International Finance indicates. The EU is attracting a significant share of these account surpluses, which might further rise, in case the Gulf States move towards an agenda of diversifying currency holdings.
It is estimated that GCC’s capital outflows towards the European Common Market accounted for around one fifth of Gulf’s total capital outflows between 2002 and 2006. Around 20 percent of GCC’s overall portfolio investment and around 55 percent of Gulf’s total direct investment were directed towards the EU. While the ratio of direct investment is marginal, yet it clearly indicates a strategic alignment towards the EU.
To conclude, an international dialogue should build upon existing rules and regulations within an agenda of well-defined mutual strategies. It might contribute to mutual trust while keeping markets open in times when economic ties have deepened and widened — especially in the context of the EU-GCC FTA.
(Nermina Biberovic is research associate of economics at Gulf Research Center, Dubai)
